Thankfully, the Tax Court did draw a distinction between the taxability of “Thank You Points” and frequent flyer miles attributable to business or official travel using Announcement 2002-18 (linked above), wherein the IRS made clear that they would not tax frequent flyer miles attributable to business travel. But that’s where the good news for taxpayers stopped.

TaxGrrrl thinks its a bad result:

In a case of what could be characterized as bad facts making bad law, taxpayers didn’t put up much of an argument for not including the income on the tax return: there was no lengthy brief explaining why it might be excludable. Nor did the IRS say much about the inclusion: they more or less took the position that Citibank’s form was enough to prove income, saying “we give more weight to Citibank’s records.”

The Tax Court made this a “reported” decision, which signals that they will side for the IRS in taxing miles that show up on 1099 information returns.

The tax law certainly allows non-cash transactions to be taxable. If they didn’t, barter exchanges would rule the world. It’s also true that at some point trying to tax everything of value doesn’t make sense. You might value the smile from the cute barista on the skywalk, but that doesn’t mean you should pay tax on the extra value received with your coffee. The hard part now is knowing when you cross the line.

As of January 1, 2014, a number of long-time options became illegal under the ACA. Lest employers are tempted to ignore this issue, they should know that offering noncompliant plans subjects them to a possible excise tax of $100 per day per employee per violation. ACA violations are no small matter.

…

In IRS Notice 2013-54, issued last fall, the Treasury Department and the Department of Labor made clear that such plans are no longer allowed. This prohibition applies to a number of long-used standalone health care reimbursement plans that are not integrated with an ACA-compliant group health care plan. Although some exceptions apply, the ACA has made the following types of reimbursement plans illegal (subjecting their sponsors to the possible $100/day/employee/violation penalty tax):

If you think that you don’t have to worry about Obamacare because you don’t have 50 employees, think again.

Roger McEowen, Structuring the Business: S Corporation or LLC?. “But, beyond the requirement to pay reasonable compensation, the S classification provides a means for extracting money out of the business without paying employment taxes – there isn’t any employment tax on distributions (dividends) from the S corporation.”

Is it okay to show the purchase as a miscellaneous deduction if the amount is less than 2% of their income and thus isn’t deductible anyway?That way, the taxpayer sees it on their tax return but technically the government hasn’t been harmed because the amount was too small to actually be deducted. Is this okay?

This can be tempting for a practitioner. You can “take” a deduction for “subscriptions” that are probably Sports Illustrated and appease a pushy taxpayer without actually reducing taxes. But Jason makes good points as to why it can make it hard to stop taxpayers from pushing for bogus deductions that actually matter.

A lawyer in the IRS ethics office is facing the possibility of being disbarred, according to records that accuse her of lying to a court-appointed board and hiding what she’d done with money from a settlement that was supposed to go to two medical providers who had treated her client.

Of course, given Commissioner Koskinen’s policy of stonewalling and evasion, she might be just the woman he wants for the job. (Via TaxProf)

You shouldn’t assume that the lower rate caused the revenue increases. Still, when our current rates clearly incentivize tax-saving moves like inversions, you shouldn’t assume rate cuts will be big revenue losers, either. The revenue-maximizing rate has to be influenced by rates charged in other jurisdictions.

Cara Griffith,Is the Dormant Commerce Clause in Jeopardy? (Tax Analysts Blog) “In matters of state taxation, the dormant commerce clause provides a much stronger defense against discriminatory taxation than the due process clause.”

As we approach the October 15 extended deadline for 1040s, some taxpayers face a tough call: they still haven’t received all of their K-1s. Yes, the extended K-1 deadline is normally September 15, but sometimes failure to file on time is an option for partnerships and S corporations, and the K-1s just aren’t done on time. The tax law tells you to report the income as best you can, and amend if you get better information. The IRS usually will understand.

Except when you control the S corporation with the delinquent K-1s.

A Californian, Dr. Sampson, owned two S corporations. His preparer hit a wall preparing the S corporation returns, according to the Tax Court (my emphasis):

Mr. Araradian has been preparing returns for Dr. Sampson and the corporations for many years. He receives the information necessary to prepare the corporations’ tax returns from Dr. Sampson’s administrator, who keeps general ledgers for both corporations using a computer program, QuickBooks, which is available to Mr. Araradian electronically. He also receives copies of the actual documents, such as bank statements and payroll reports, underlying the entries in QuickBooks (source documents), which he believes are necessary to verify the data in QuickBooks. before he will prepare a tax return. For neither of the years in issue did either corporation provide source documents to Mr. Araradian before the respective dates on which their Forms 1120S for those years were due. The corporations’ Forms 1120S for those years were delinquent because, without source documents Mr. Araradian would not prepare those returns.

Well, he still had the Quickbooks files, so he should be able to throw together a tentative taxable income number for the doctor, right? Apparently not:

And since he had not prepared the corporations’ returns by the dates on which petitioners’ 2008 and 2009 Forms 1040, U.S. Individual Income Tax Return (together, original returns), were due, Mr. Araradian did not have the corporations’ Schedules K-1, Shareholder’s Share of Income, Deductions, Credits, etc., from which to enter pass-through items from the corporations on the original returns.

Consequently, Mr. Araradian prepared the original returns omitting any income or losses passed through to petitioners from the corporations. He told Dr. Sampson in each case that he was making a statement on the return saying that pass-through items from the corporations were not being included. The statement that he made on each return is as follows:

THE ENCLOSED TAX RETURN FOR REGINALD AND GERVEL SAMPSON DOES NOT INCLUDE THE K-1’S FROM MONTEBELLO MEDICAL CENTER, INC. * * * AND REGINALD SAMSPN [sic] MD A PROF CORP * * *. THE * * * [2008/2009] PERSONAL INCOME TAX RETURN FOR REGINALD AND GERVEL SAMPSON WILL BE AMENDED ONCE THE TAXPAYER RECEIVES THE * * * [2008/2009] K-1’S.

So he had the Quickbooks files, but he just used zeros. For two years. That turned out to be less than the income that should have been reported, leading to over $130,000 in additional tax. The IRS didn’t think that was reasonable and assessed penalties.

The taxpayers argued they filed a “qualified amended returns” for the two years. The judge pointed out that the amended returns were filed after the IRS had contacted the taxpayers, so they didn’t work.

It seems strange to me that the preparer wouldn’t file a return based on the Quickbooks file alone, though maybe he felt the doctor’s bookkeeping wasn’t to be trusted without support. Given the penalties for filing late S corporation returns, it’s surprising that the doctor didn’t turn over the “underlying documents.” Considering that he had quite a bit of information in the Quickbooks files about the K-1 income, it’s surprising that they used zeros on the doctor’s 1040, instead of an estimate based on Quickbooks numbers. But the tax law can be full of surprises.

The moral? If you don’t have perfect information, the zero option may not be your next best option. If you can’t file perfect, it’s better to file something, and to try to make it as close as you can.

Yes, increasing rates on the wealthy also increases tax rates on businesses.

Don Boudreaux, It’s Not Really a Taxingly Difficult Subject (Cafe Hayek): “Among the most economically naive calculations that people (including government officials) make is to estimate the growth in tax revenues based on the assumption that nothing changes beyond a hike in the tax.”

Clint Stretch,Healthcare and Tax Reform: “Repealing the employer-provided healthcare exclusion might make sense in economic theory, but in the practical world, it would accelerate a day of reckoning on healthcare for which we are unprepared.”

The senior members of these families are pressuring the younger generation give up U.S. citizenship to protect against these problems. I have heard the ultimatum from the father to the son: “The business or your U.S. passport. You choose.”

I want to emphasize that I do not hear political rants from my clients, or from the other family members who must deal with having a U.S. citizen shareholder thrust upon them. Everyone I talk to is eager to travel to the United States, enjoys meeting Americans, and bears no ill will to anyone.

But faced with the prospect of destroying the family business or giving up the U.S. passport, it is no contest. The passport has to go.

40% of the value of your business, as second-guessed by the IRS, can be a high price for a passport.

Sorry, “Mom.”The Tax Court yesterday found a problem with a claim for a dependent exemption:

Petitioner has failed to show that she is entitled to the dependency exemption deduction for Mr. Salako. Petitioner claimed on her 2008 return that Mr. Salako was her son. Mr. Salako was born on January 12, 1961, and was thus 47 years old at the close of 2008. Petitioner, born in 1959, is only two years older than Mr. Salako. Thus, he cannot be her biological son, and we do not find credible petitioner’s unsubstantiated testimony that Mr. Salako is her adopted son.

Just 3 percent (or 6,508) of all non-profits have assets of $50 million or more. However, these organizations took in 73 percent of all non-profit revenues and commanded 81 percent of all assets held by non-profits.

Most of us have heard of doctors without borders, but has anyone heard of textbooks with borders? It’s a reality for those using Amazon’s textbook rental service. The reason for this is very likely related to Amazon’s recurring sales tax issues.

One thing I like about S corporations is that while corporation income is taxed on shareholder’s 1040s, income on the K-1 isn’t subject to payroll or self-employment tax.

Except when it is.

Mr. Blodgett had an S corporation called Glass Blocks Unlimited, which “sold and distributed ‘glass blocks’ for the real estate market in North America.” He was the sole shareholder and president of the company.

He worked full time for petitioner, which had no other full-time employees. He was responsible for all operational and financial decisions of the company, and he performed nearly all of the work necessary to run the business. Petitioner additionally used an unspecified number of day laborers, whom it paid totals of $39,733 and $41,453 in 2007 and 2008, respectively.

Petitioner did not on its 2007 and 2008 Forms 1120S report paying Mr. Blodgett a salary or wages. It did, however, distribute money to him as cash was available and he asked for it. Petitioner distributed not less than $30,844 to Mr. Blodgett over the course of 2007. During 2008, petitioner made distributions to Mr. Blodgett totaling not less than $31,644.

The IRS treated the distributions as taxable wages to the taxpayer and assessed FICA and Medicare taxes. The taxpayer disagreed, saying that the his “reasonable” compensation was lower than that assessed by the IRS. The judge sided with the IRS:

As president of the company, Mr. Blodgett was petitioner’s only officer. Mr. Blodgett was also petitioner’s sole full-time worker in 2007 and 2008. He performed substantially all of the work necessary to operate the business, including processing orders, collecting payments, arranging shipment of goods, managing inventory, and handling customer relations. His services generated all of petitioner’s income.

Because Mr. Blodgett was petitioner’s employee for the periods at issue and performed substantial services for it yet it did not pay him a salary, its distributions to him are deemed wages and thus are subject to Federal employment taxes.

The taxpayer also said some of the distributions were repayment of loans to the company. Here the taxpayer was the victim of informal bookkeeping:

There were no written agreements or promissory notes supporting Mr. Blodgett’s testimony that the transfers were loans. While it is true that a portion of the transfers was reported as loans from shareholders on petitioner’s Forms 1120S, that entry is of little value without the support of other objective criteria. Indeed, petitioner did not even report the $10,000 transfer as a shareholder loan on its 2008 return. The absence of notes or other instruments, plus petitioner’s failure to treat the $10,000 transfer as a loan at all, indicates that the transfers were not loans.

To make things worse, the court upheld late payment penalties on the payroll taxes.

I think the taxpayer gets a raw deal here. The IRS imposed $30,844 of wages on the taxpayer in 2007, even though the corporation’s net taxable income for the year was only $877, not counting the “wages.” It hit him with another $31,644 if wages for 2008, when pre-wage income was only $8,950. In other words, the Tax Court expected the corporation to incur a taxable loss just to generate some payroll taxes for the IRS. That’s ridiculous, and a worse result than the same taxpayer would have had running the business on a Schedule C.

Furthermore, the Tax Court was too cavalier in disregarding the loans and repayments. It’s wrong to expect a one-man corporation to generate prissy paperwork when the shareholder advances funds. Yet because he didn’t have pieces of paper with the magic words, he got stuck with payroll taxes — and penalties.

The Moral? When advancing and withdrawing funds from an S corporation, be sure to generate the appropriate prissy paperwork. And if a wholly-owned S corporation generates enough cash to distribute to an owner working in the business, set a salary and pay the payroll taxes on at least a “reasonable” amount, or the IRS might impose payroll taxes on all of it. You have to protect yourself from an unreasonable IRS assessment, because it looks like the Tax Court won’t.

The tax law “passive activity” rules were written to shut down real estate shelters by making rental losses “passive,” deductible only to the extent of “passive” income. About 3 seconds after the rules were enacted, taxpayers began thinking of ways to generate passive income so they could deduct their passive losses by renting land or by renting property to a controlled business activity. Rules treating “land rent” or “self-rental” net income as non-passive were issued quickly to stop that.

The new Obamacare 3.8% tax on “investment income” will apply to “passive income” as determined under the passive loss rules, so a Tax Court decision issued yesterday exploring these issues takes on added importance.

The taxpayer leased land with cell-phone towers to his wholly-owned S corporation. The S corporation in turn leased the towers to phone companies. The taxpayer also leased land to his S corporation.

The S corporation mistakenly reported the income from its leases to the phone companies as ordinary income, rather than rental income, lumping the tower rental with the S corporation’s other business income. The taxpayer treated the income as non-passive.

The towers leased to the S corporation were reported as passive leases on the taxpayer’s 1040, as were the land rents. Some tower leases were profitable while others generated losses, but because they were all reported as “passive,” the losses and income offset.

The IRS had other ideas. The IRS left the K-1 income as non-passive, saying that the leases to the phone company wasn’t really “rental,” and in any case the taxpayer was stuck with the way the income was reported. The IRS split the income from “self-rental” of the towers to the controlled corporation, with the losses treated as passive and the income reclassified as non-passive under the self-rental rules. The bottom line: a lot of non-passive income that couldn’t be offset by the now non-deductible passive losses.

The Tax Court said the IRS was being too cute. The IRS said that the taxpayer was bound by his treatment of the S corporation tower income as non-passive because he had already grouped it with his other activities. Judge Halpern said the IRS regulations didn’t have to cause such a harsh result. While the taxpayer might be stuck with its return reporting for determining whether to report income from the K-1 as passive, that didn’t extend to the self-rental rules. so the taxpayer didn’t have to split up the cell-tower rental to the S corporation between profitable (non-passive) and loss-generating (passive):

We recognize that, because ICE erroneously reported all of its income as ordinary business (non-passive-activity) income, nonapplication of the self-rental rule of section 1.469-2(f)(6), Income Tax Regs., to ICE’s rental payments to petitioner, in effect, results in the reduction of what was reported as “active business income” and the offsetting creation of “passive income” in seeming contravention of the congressional conferees’ directive to issue regulations preventing that result. See H.R. Conf. Rept. No. 99-841 (Vol. II), at II-147 (1986), 1986-3 C.B. (Vol. 4) 1, 147. We do not believe, however, that ICE’s tax return mischaracterization of its tower access rental income from third parties should control the application of the self-rental rule where, as here, it is, by its terms, inapplicable, i.e., where petitioner’s towers were not, in fact, used in a trade or business. Moreover, we are not persuaded that the result we reach herein violates the conferees’ directive as it does not, in fact, permit “passive income” to offset “active business income”.

The Tax Court upheld the IRS in treating the land-rental as non-passive.

The Moral? The Tax Court reached a fair result, even though it had to stretch around the regulations to do so. Had the towers been rented to the S corporation for use in its non-passive business, the judge would probably have given the IRS its “heads I win, tails you lose” treatment — the income would have been non-passive, and the losses would have been passive and non-deductible. The result was different because the S corporation in turn leased the properties to third parties, instead of using them in its non-passive business.

The result is fair because the taxpayer isn’t really generating improper passive income that wouldn’t be there if it had reported the income on the K-1 properly in the first place.

This case reminds us how important it is to identify your passive activities and group them properly. With the 3.8% tax on passive income taking effect in January, this is even more important.

The executor files an estate tax return valuing a 15% interest in an LLC at $34,936,000.
The IRS audits the estate tax return. They value the interest at $49,500,000, assiessing a deficiency of $6,990,720.
The Tax Court yesterday rules the correct value is $32,601,640. At the 48% estate tax rate that applies for 2004, that gives the estate a refund of $861,422.
It’s a good thing they audited that return, because that will help Commissioner Shulman pay to regulate more preparers.
Cite: Estate of Louise Paxton Gallagher, T.C. Memo. 2011-148